Polestar: Assessing The Implications Of Shutdowns (NASDAQ:PSNY)

Polestar’s stock (NASDAQ:PSNY) has been an underperformer across the broader electric vehicle (“EV”) peer group this quarter, with declines of close to 15% since its Nasdaq debut in late June. Yet, the Swedish EV maker has some of the best fundamentals compared to other EV upstarts that have only recently entered start of productions. Polestar has delivered more than 21,000 cars in the first half of 2022, representing a y/y increase of close to 125% to corroborate the advantage of leveraging the manufacturing experience of its key backers Volvo (OTCPK:VOLAF / OTCPK:VLVLY / OTCPK:VOLVY) and Geely (OTCPK:GELYY).

The near-term discrepancy between Polestar’s fundamental strength and valuation slump is likely a result of broad-based market concerns over its exposure to China production headwinds, given ongoing supply chain disruptions stemming from sporadic COVID lockdowns, and more recently, a drought and subsequent power crunch in Sichuan city that is threatening to upend EV productions in the region again.

The following analysis will aim to explore the downside risks to Polestar’s underlying business performance as well as their implications on the stock’s near-term outlook. Considering Polestar continues to deliver positive progress on a fundamental basis that has largely outperformed its broader peer group of EV upstarts, which demonstrates resilience and strength in navigating through unprecedented industry-wide production challenges, we remain optimistic that the stock’s upside will re-emerge stronger once the cloudy sentiment subsides.

Understanding the Near-Term Downside Risks

China is currently home to the bulk of Polestar’s production base. As discussed in our previous coverage, Polestar’s best-selling vehicle – the Polestar 2 sedan – is currently being produced in Volvo’s owned and operated manufacturing facility in Taizhou, Zhejiang province. Meanwhile, the Polestar 3 SUV that will enter start of productions later this year will take place at Volvo’s Chengdu and Charleston (U.S.) manufacturing facilities. And later models – namely, the Polestar 4 premium SUV and Polestar 5 premium 4-door GT – entering start of productions in 2024 will take place across Geely’s facility in Hangzhou Bay and Chongqing.

Issue: In addition to widespread COVID infections across major Chinese auto manufacturing hubs in Shanghai, Jiangsu, Zhejiang and Jilin during the second quarter, which drove direct and indirect impacts to Polestar’s production volumes due to sporadic factory lockdowns and supply chain disruptions, the EV maker is now facing the added threat of a power cut in Sichuan province announced this week.

China’s Sichuan province, which has 80% of its power supply coming from hydroelectric dams, is currently facing “the most intense heat wave in more than half a century”. With critical water reservoirs drying up, the government has ordered “extended industrial power cuts this week” in the region as part of measures to conserve energy and ensure an efficient balance in supply to its people through the drought. The latest development makes another challenge to Chinese EV manufacturing this year, as Sichuan province currently houses “more than a fifth of China’s lithium production”, a critical link in the industry’s supply chain. CATL, the world’s largest EV battery maker and one of two key battery component suppliers to Polestar, became one in a growing list of manufacturers that have shuttered their plants in Sichuan province on government orders this week.

Implications: Polestar’s key manufacturing facility for its best-selling Polestar 2 is currently located in Chengdu, Sichuan province, which exposes it directly to the recent power curtailment enforced in the region. While the EV maker has yet to provide any comments on how the region’s ongoing drought has impacted its production volumes in recent weeks, related investor concerns are already being reflected in the stock’s steep declines observed since mid-August.

The nearby municipal of Chongqing – home to Volvo and Polestar’s owned and operated manufacturing facilities that will soon be housing the production of the Polestar 3 SUVs – has also become victim to the widespread drought and heatwave across southwestern China. Factories across Chongqing have been ordered to “suspend operations for seven days starting last Wednesday”, and it is currently uncertain if the curbs will be extended or if start of productions on the Polestar 3 expected in 4Q22 will be pushed back.

In addition to potential production delays, the latest power crunch in China’s key auto supply manufacturing hubs also risks further margin erosion for an industry that has already been reeling from the aftermath of ongoing supply chain snarls over the past year. As mentioned in the earlier section, key EV component manufacturers including CATL have been looped into the latest energy crisis in Sichuan province, risking a repeat of supply bottlenecks that have only recently shown signs of easing from earlier COVID disruptions. Lithium prices are nearing the highest levels on record, with the refined compound lithium carbonate used in EV batteries exceeding $70,000 a ton earlier this week as the power crunch in Sichuan province threatens the region’s production of said materials. This accordingly points to further input cost headwinds in EV production for Polestar in the near-term, which could potentially lead to an unfavourable impact on its bottom-line in the near-term. This is further corroborated by recent observations in Chinese EV maker XPeng (XPEV), which reported another consecutive quarter of margin declines in the three months through June due to “higher material and battery costs”, despite having raised prices earlier in the period.

Offsetting Considerations: Despite potential production challenges and margin pressures in the near-term due to Polestar’s significant exposure to China’s COVID and drought-induced supply chain snarls, we do not expect any material delays to Polestar’s profit trajectory. Recall that the best-selling Polestar 2 sedan, as well as the upcoming Polestar 3 SUV leverages the same vehicle platforms – “Compact Modular Architecture” (“CMA”) and “Scalable Product Architecture 2” (“SPA 2”) – across Volvo and Geely’s existing product pipeline. This accordingly gives Polestar an ability to take advantage of economies of scale in related production supplies, while also managing long-term component availability and costs – a key competitive advantage to outperform peers in mitigating the pronounced production and margin challenges across auto productions in China today.

The EV maker is also in the process of implementing a second shift at its manufacturing facility in China to “recover some of the production lost earlier in the year” due to COVID disruptions in 1H22. While the related press release did not specify which facility will benefit from the expanded capacity, we expect it to be Volvo’s Taizhou plant, which currently produces the Polestar 2. The Taizhou facility currently boasts an annual production capacity of 180,000 vehicles, and is shared between the productions of the Polestar 2, as well as Volvo’s XC40 and XC40 Recharge. With the COVID situation in Zhejiang province now largely under control, we expect Polestar to benefit from the added shift, which provides further validation to its reaffirmed delivery guidance of 50,000 vehicles by the end of the year.

With more than 21,200 cars delivered in 1H22, Polestar is still more than 28,800 vehicles out from achieving its annual target. Based on the weekly production run-rate of 815 vehicles in the first half of the year, and considering doubled capacity to ramp up near the latter parts of 2H22, Polestar should be well-positioned to achieve or even exceed its delivery target of 50,000 vehicles for the year.

Recall that Polestar’s guided delivery target of 50,000 vehicles has already been downward-adjusted from the initial expectation of 65,000 vehicles earlier this year due to industry-wide supply chain constraints. Considering the Swedish EV maker’s track record of being the only upstart in the industry to have met/exceeded prior year guidance, the added shift in 2H22 could potentially bring Polestar closer to its initial delivery target and strike another round of outperformance.

Other Corners of Strength

As mentioned in the earlier section, Polestar has been one of the few EV pureplay upstarts that have consistently demonstrated on-track progress towards achieving its annual delivery guidance. This compares to peers that have either repeatedly adjusted production guidance due to near-term supply constraints, or remain more than 50% away from achieving annual volume targets. In fact, the Swedish EV maker continues to demonstrate prudent execution in leveraging the production advantage from its parent companies and shows promising prospects of potentially delivering outperforming results by year-end despite the ongoing auto supply crisis that has upended the industry’s operations over the past year.

The EV maker’s upcoming launch of the Polestar 3 is also expected to be a key catalyst for the stock later this year. Based on the latest official update from Polestar, its flagship SUV will be unveiled in October, with reservations to open on the same day of the vehicle’s debut. In addition to Volvo’s Chengdu facility, the Polestar 3 will also be produced at the U.S. Charleston facility. This accordingly puts Polestar on the map for benefiting from the recently introduced $7,500 tax incentive in the U.S., considering the vehicle will be produced in North America with a price tag starting at under the $80,000 eligibility threshold for SUVs.

Paired with favourable EV and SUV take-rates in the U.S. and Europe – two of Polestar’s core sales regions where SUVs account for more than half of annual new car registrations – the upcoming addition of the Polestar 3 to the EV maker’s roster would make a key boost to top-line growth. And by implementing a platform-sharing model for the Polestar 3, which leverages the SPA 2 platform that is expected to be applied in future models across Polestar and potentially Volvo and Geely, the company’s flagship SUV is expected to become its highest margin vehicle made to date, further supporting its profit roadmap which is expected to materialize by mid-decade.

Polestar_-_Forecasted_Financial_Information.pdf

Author’s Note: For further detail on forecast assumptions applied, please see here.

Final Thoughts

Considering Polestar’s recently reaffirmed delivery guidance of 50,000 vehicles, as well as the expectation for mitigated impacts to its near-term fundamental performance under ongoing COVID disruptions and the latest energy crisis in China auto productions, we remain optimistic on the Polestar’s upside potential. The ongoing paradox between the stock’s recent declines and its fundamental outperformance to peers demonstrated in 1H22 continues to foreshadow a stronger re-emergence once the dour industry sentiment that has been overshadowing Polestar’s recent achievements subside, making it a favourable investment at current levels.

While we expect further turbulence for the stock in the near-term as the market grapples with uncertainties over how Polestar’s manufacturing capabilities have been managing under China’s constrained industrial sector, we are maintaining our price target of $18, which represents upside potential of more than 110% based on the shares’ last traded price of $8.50 at the time of writing (August 24).